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Economic Issues by Ishrat Hussain PDF
Economic Issues by Ishrat Hussain PDF
Inaugural address by Mr Ishrat Husain, Governor of the State Bank of Pakistan, at the Seminar on
Management of Pakistan Economy, organised by the Lahore School of Economics, Lahore,
28 April 2005.
* * *
1. Introduction
Pakistan was one of the few developing countries that had achieved an average growth rate of over
5 percent over a four decade period ending in 1990. Consequently, the incidence of poverty had
declined from 40 percent to 18 percent by the end of 1980s. But the 1990s proved to be a lost decade
for Pakistan; growth in per capita income dropped to slightly over 1 percent. Poverty resurfaced and
about one-third of the population now lives below the poverty line of $1 per day. Social indicators
became worse than those of other countries with comparable incomes. The country became one of
the heavily indebted countries and was declared as one of the most corrupt countries in 1996. The
challenge facing the government which assumed power in October 1999 was to put the economy back
to its pre-1990 track.
Pakistan has come a long way since the 1998/99 crisis when the country was on the brink of default
and international reserves had been depleted, economic growth was anemic, debt ratios were
alarmingly high, confidence of the investor community was at its lowest ebb and credibility among
international financial institutions was eroded. Economic growth rate has reached a solid 6 percent
plus, inflation has been contained to 5 percent which has only recently started rising, exchange rate
has been stabilized, fiscal deficit has been drastically reduced, domestic interest rates have declined
dramatically, international reserves have jumped twelve times their 2000 level, debt ratios have fallen
significantly and investment is booming. Pakistan’s creditworthiness has been upgraded to B+ by
S&P. It is one of the few developing countries that have graduated from a successful completion of an
IMF program to directly accessing international financial markets.
I would start off with an overview of the economic reforms and policies put in place by the government
since 2000, examining their main components, their aims and objectives and the degree of success
achieved. I will then offer an assessment of the experience during this period and then offer some
concluding remarks.
Tax reforms
Tax reforms have attempted to widen the tax base, strengthen tax administration, promote
self-assessment, eliminate whitener schemes, reduce multiplicity of taxes and tackle the culture of tax
evasion and corruption. A new Income Tax Ordinance has been introduced in 2001, which allows for
universal self-assessment, uniform tax rates, removal of non-adjustable withholding taxes, elimination
of exemptions and detailed audit. Moreover, the tax survey and documentation drive during 1999-2000
has allowed the CBR to bring in additional income tax payers and new sales tax payers into the tax
Tariff reforms
Pakistan made significant efforts in liberalizing its trade regime during the 1990s. The maximum tariff
rate has declined from 225 percent in 1990-1 to 25 percent; the average tariff rate stands at just
11 percent compared to 65 percent a decade ago. The number of duty slabs has also been reduced to
four. Quantitative import restrictions have already been eliminated except those relating to security,
health, public morals, religious and cultural concerns. The number of statutory orders that exempted
certain industries from import duties has been phased out by June 2004 and import duties on
4,000 items were reduced. These measures have brought down effective rate of protection, eliminated
the anti-export bias and promoted competitive and efficient industries. A number of laws have also
been promulgated to bring the trade regime in conformity with World Trade Organization regulations.
These include antidumping and countervailing measures and strengthening of intellectual property
rights.
Privatization
Public sector corporations have been a constant source of burden on the budget as well as
quasi-fiscal accounts. As much as one-third of the fiscal deficit could be directly attributed to the losses
of public corporations. In addition, nationalized commercial banks had been carrying a large burden of
these corporations. A new law was promulgated under which privatization can take place. This step
was necessary to ensure transparency, provide an institutional and legal framework, avoid
unnecessary delays and litigations, and outline the process through which the transactions are to be
carried out.
Four major banks along with several other key public sector units have already been sold to strategic
investors in the private sector. Shares of large companies such as Oil and Gas Development
Company Ltd. and Pakistan Petroleum Ltd. have been divested through public offerings. Plans to sell
the Pakistan Telecommunications Co. Ltd. (PTCL) and Pakistan State Oil (PSO) – the two giants - are
under implementation.
Deregulation
As Pakistan has embarked on the process of creating competitive markets and eliminating direct or
implicit consumer and producer subsidies, a number of steps have been taken to deregulate prices
and trading in various sectors. The most far-reaching reform has taken place in the oil and gas sector.
Imports and pricing of petroleum products have been deregulated and the private sector is now free to
import and fix prices. An automatic price adjustment formula for consumer prices of petroleum
products linked with international prices has been adopted. Price distortions in natural gas have also
been eliminated and new pricing framework has been put in place.
The government has freed up agricultural prices by moving towards market based pricing. With a view
towards allowing farmers to receive international prices for their produce, all restrictions on the import
and export of agricultural commodities have been removed. Wheat procurement and trade, which was
until recently an exclusive monopoly of the state, has been opened up to the private sector. Exports of
wheat and wheat products have also been allowed to the private sector.
Deregulation and liberalization of the economy have given rise to an interesting by product –
weakening of the public functionaries’ power to collect rents, extort bribes and exhibit arbitrary
behaviour. This has a positive impact on the quest for improved governance in the country.
Institutional reforms
Civil service reforms aimed at improving recruitment, training, performance management, career
progression, right sizing of ministries and attached departments, and improving compensation for
government employees are the reforms that have been initiated for building strong institutions in the
country. In order to depoliticize recruitment, promotions and career development, the independence
and responsibilities of the Federal Public Service Commission (FPSC) have been enhanced and is
now fully in charge of merit based recruitment and promotions. The Civil Service Act has been
amended to reflect performance based career progression and would enable the government to retire
civil servants who are inefficient and/or corrupt. The public sector educational training infrastructure is
also being restructured to strengthen skill based training of civil servants at all levels.
The reforms in some of the most important federal institutions – the Central Board of Revenue (CBR),
Securities and Exchange Commission of Pakistan (SECP), the State Bank of Pakistan (SBP) and
Pakistan Railways – initiated some years ago - are already beginning to take some hold and making a
difference as far as governance is concerned.
Reforms in access to justice will deal with delays in the provision of justice, case management,
automation, and court formation systems. In addition, human resources, management information
systems and the infrastructure supporting judicial system are being revamped and upgraded. Small
Causes Courts have been established to provide relief to the poor who have small claims.
Extensive police reforms have been introduced to separate the law and order, investigation, and
prosecution functions of the police and promote functional specialization. Public Safety Commissions
have been set up at the federal, provincial and district levels, which will institutionalize public
accountability of Pakistan’s Police Force. To improve the overall performance of the policy, enhancing
efficiency, logistics, communication, mobility and training are to be given greater emphasis. The
example of motorway police in this respect is illustrative of the quick turnaround that can be brought
about through better incentives and logistic support.
The progress on institutional reforms in Pakistan has not made any serious strides with a few
exceptions such as the State Bank of Pakistan, Securities and Exchange Commission of Pakistan
(SECP), Auditor General and more recently the Central Board of Revenue. Devolution to local
government which started off very well on a good footing in 2001 has got stuck in sorting out the
provincial - local government relationships.
Public works
Khushal Pakistan Program had generated economic activity in the country through local public works.
The provinces, in close collaboration with the local authorities and communities, completed almost half
a billion dollars of small projects creating about 1 million job opportunities along with essential
infrastructure in rural and low income urban areas. The program has resulted in construction of
farm-to-market roads, rehabilitation of water supply schemes, repair of existing schools, small rural
roads, streets, drains, and storm channels in villages. Moreover, the program has been supplemented
with the schemes for lining of watercourses and laser land leveling, desilting canals, and provision of
civil amenities in towns, municipal committees, and metropolitan corporations.
3.1 Assessment
In making the assessment of the last five years. I will address two questions that are uppermost on the
minds of most Pakistanis within or outside the country.
The first question that arises in the discussion of Pakistan’s economic turnaround is as to how much of
this can be attributed to the favourable external environment created as a result of 9-11 and how much
is due to better economic management.
My own assessment of the situation is that while the favourable external environment has definitely
helped and reinforced the thrust of the economic policies and reforms, its impact would have been
short lived and transitory in absence of the reforms and policies and improvement in governance that
have been undertaken during the last five and a half years. The macroeconomic indicators had started
looking good even before Sept. 11 but the removal of sanctions, resumption of assistance, and
diversion of remittances through the banking channels did definitely provide an impetus. I would argue
that the reprofiling of Paris Club Debt would have taken place in any event as the IMF had agreed on
the three-year PRGF and debt reprofiling upon the successful completion of the 9-month Stand-by
Program before Sept. 11. It should be kept in mind that the impact of Sept. 11 upon the Pakistan’s
economy has not been, by any means, an unmitigated blessing. Export orders were cancelled and
export target for that year was missed by $1 billion. Shipping freights and insurance premia were
raised substantially, foreign investors and buyers stopped visiting Pakistan and the fledgling I.T.
industry suffered a severe set back. Some of the consequences of that shock are still lingering on in
form of a negative perception of Pakistan in the Western media.
The quantum of assistance from the U.S. accruing to Pakistan does not form a significant proportion of
our foreign exchange receipts. If we combine all the bilateral official flows from the U.S. they do not, on
average, exceed $1 billion annually. Pakistan’s foreign exchange earnings will amount to $25 billion
this year. Thus, contrary to the popular belief that Pakistan’s economy will collapse if the U.S.
withdraws its official assistance, the truth of the matter is that the amounts involved are too
insignificant. What we really need from the U.S. is better market access to our exports on the same
terms as allowed to the Central American, Caribbean and African States. Pakistan can earn twice as
much as it will receive in official assistance from the U.S., if this market access is allowed.
The second popular view that is commonly prevalent is that we do not have independent economic
policies and that we follow the policies dictated to us by the IMF and the World Bank. It is true that
when we needed the IMF’s assistance to reprofile our Paris Club Debt we had no choice at that time
but to comply with the conditionalities set by them. But once we had achieved that objective and had
set our own house in order, it was no longer necessary to agree to all their conditionalities. We did
agree and implement those which were beneficial to our own interests.
Most of the policies prescribed by them e.g. fiscal discipline, mobilizing tax revenues, removing tariff
barriers, privatizing public enterprises, maintaining low inflation, etc. all make perfect sense and no
economist in his right mind could take an issue with them. Where the shoe pinches is that these
policies are reduced to quantifiable targets and performance criteria for each quarter and for any
slippages or deviations, however, legitimate they may be during that particular quarter, the country is
penalized and its reputation is put in jeopardy. This sort of micromanagement is resented by the
economic managers of the developing countries. I would argue that as long as the country is moving
on the right path in implementing the desirable set of reforms, the speed, phasing and sequencing
should be left to the economic managers and not controlled by the IMF. As you are all aware that we
have said good-bye to the IMF since September 2004 and did not draw down the last two tranches to
which we were entitled to on the basis of our performance. In the past, if we were confronted with the
3.2 Conclusion
Pakistan has achieved macroeconomic stability, introduced structural reforms, improved economic
governance and resumed the path for high growth rates. But there is no room for complacency as we
are confronted with challenges of poverty reduction, employment generation, balanced regional
growth, upgrading social indicators and containing inflation.
The second generation reforms aimed at strengthening the country’s institutions and their capacity to
deliver basic services along with the continuation of sound and consistent economic policy and
investment in human development and infrastructure will be able to steer the country on the right
course.